Bank loans are available to finance the purchase of inventory and equipment as well as to obtain operating capital and funds for business expansion. These loans are a time-honored and reliable method of financing a small business, but banks often only finance firms with substantial collateral and a long track record, and the terms they offer are often very strict. Business owners should weigh the advantages and disadvantages of bank loans against other means of finance.
Advantage: Keep Control of the Company
A bank loans money to a business based on the value of the business and its perceived ability to service the loan by making payments on time and in full. Unlike with equity finance where the business issues shares, banks do not take any ownership position in businesses. Bank personnel also do not get involved in any aspect of running a business to which a bank grants a loan. This means you ghet to retain full management and control of your business with no external interference.
Advantage: Bank Loan is Temporary
Once a business borrower has paid off a loan, there is no more obligation to or involvement with the bank lender unless the borrower wishes to take out a subsequent loan. Compare this with equity finance, where the company may be paying out dividends to shareholders for as along as the business exists.
Advantage: Interest is Tax Deductible
The interest on business bank loans is tax-deductible. In addition, especially with fixed-rate loans, in which the interest rate does not change during the course of a loan, loan servicing payments remain the same throughout the life of the loan. This makes it easy for businesses to budget and plan for monthly loan payments. Even if the loan is an adjustable-rate loan, business owners can use a simple spreadsheet to compute future payments in the event of a change in rates.
Disadvantage: Tough to Qualify
One of the greatest disadvantages to bank loans is that they are very difficult to obtain unless a small business has a substantial track record or valuable collateral such as real estate. Banks are careful to lend only to businesses that can clearly repay their loans, and they also make sure that they are able to cover losses in the event of default. Business borrowers can be required to provide personal guarantees, which means the borrower’s personal assets can be seized in the event the business fails and is unable to repay all or part of a loan.
Disadvantage: High Interest Rates
Interest rates for small-business loans from banks can be quite high, and the amount of bank funding for which a business qualifies is often not sufficient to completely meet its needs. The high interest rate for the funding a business does receive often stunts its expansion, because the business needs to not only service the loan but also deal with additional funding to cover funds not provided by the bank. Loans guaranteed by the U.S. Small Business Administration offer better terms than other loans, but the requirements to qualify for these subsidized bank loans are very strict.